Tuesday, January 22, 2008

Greg Ip reviews recession odds

Recently, credit spreads have widened sharply, but the yield curve has steepened. “The offsetting effects capture a lot of what is happening in the outlook. The economy is worse off, as reflected in wider spreads, but the Fed is riding to the rescue, as reflected in the steeper curve.” Based on recent quotes, “the odds of a recession [in the next 12 months] are less than 10% (see chart below), down from over 40% in early 2007,” Mr. Sack says. He adds: “We run bunch of these types of models, and they all give different results, so I’m not sure any single model should be taken too seriously. I think we would subjectively put the probability of recession above the 10% from this model, but below the 30% to 50% figures that are commonly cited.” One of his favorites “includes the yield slope, risky asset prices, and increases in the unemployment rate. It says the odds are around 40%.”